I’m now going to tell you about Conn’s (NASDAQ: CONN) first-quarter earnings for fiscal 2016. You will be appalled at how bad they are. Then you will shake your head as to why the stock is up. Then your jaw will drop when you see the company’s valuation. What you do after that is up to you.
First, recall how Conn’s stock got on to everyone’s radar. The furniture and appliances retailer was posting massive increases in same-store sales, a metric I talk a lot about when it comes to retail. We were seeing 20% and higher. Everyone, including me, thought this business was on fire.
Then we started seeing massive delinquencies, because Conn’s was essentially lending money through its in-house financing program to anyone with a pulse. The stock cratered into the high teen but has since more than doubled, thanks to ridiculously optimistic sentiment by the market.
Let me provide you with the earnings report and you’ll see why I’m not impressed. Conn’s earnings plunged 80% year over year. That’s just to start. Revenue, though, increased 8.8% year over year to $365 million. But hold on, because this was driven by new store openings. When you factor in the negative 4.3% comparable-store sales, things aren’t so impressive anymore.
Conn’s has two segments, namely retail and credit, because most of its sales are to subprime consumers who need to credit part to engage in the retail party, partly offset by negative comparable-store sales (comps).
The retail segment saw a 7.5% increase to $298 million, but as mentioned, it was the result on new store opening. Gross margin fell 10 basis points to 41.3%.
Revenues from the credit segment increased 16% to $66 million. That’s because the receivables portfolio expanded by 25% to $1.4 billion. Now, for a company with a credit division, that’s a good thing. What we do not want to see, however, is the lousy underwriting that drove the business into the ground in the first place.
For that, we have to see what happens as the portfolio is worked off. The delinquency rate was 8.4%, which is awful, but much better than where it had been, at 9.7%. The news isn’t encouraging because the company increased its bad debt reserves by $25 million to $47 million. So while the receivables balance increased 25%, provision for bad debt doubled.
This all resulted in a wider loss in the credit segment to $8.5 million. Still, even if it removed that increased reserve level, it still would have seen a $20 million overall increase in expenses.
Conn’s own interest expense doubled year over year.
For Sale Sign
Meanwhile, Conn’s is out of cash, having only $5 million in the bank and $719 million in debt. It is using all its free cash flow to pay down debt, which is a good thing. It is also trying to sell itself, although the more likely outcome is that someone will buy its accounts receivable portfolio at a substantial discount.
The most obvious buyer of either is probably a rent-to-own operation, which Conn’s most resembles. At this point, it’s probably the only thing that keeps the company afloat. For the life of me, I have no idea why the company is selling at a $1.42 billion market cap.
A receivables buyer pays 75% of portfolio, or $1.05 billion, but it could be as low as $850 million. When the retail segment was doing all right, it produced about $120 million in profit annually. At an 8.5 times multiple, which is what most retailers might be valued at, that segment may be worth $1 billion. So you have $1.85 billion to $2.05 billion, less the $719 million in debt, and you are left with $1.13 billion to $1.33 billion.
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